# Economics in Crypto By [Milosh Yarosh](https://paragraph.com/@kyivland) · 2023-04-13 --- Cryptocurrencies are used primarily outside banking and governmental institutions and are exchanged over the Internet. ### Block rewards Proof-of-work cryptocurrencies, such as Bitcoin, offer block rewards incentives for miners. There has been an implicit belief that whether miners are paid by block rewards or transaction fees does not affect the security of the blockchain, but a study suggests that this may not be the case under certain circumstances. The rewards paid to miners increase the supply of the cryptocurrency. By making sure that verifying transactions is a costly business, the integrity of the network can be preserved as long as benevolent nodes control a majority of computing power. The verification algorithm requires a lot of processing power, and thus electricity in order to make verification costly enough to accurately validate public blockchain. Not only do miners have to factor in the costs associated with expensive equipment necessary to stand a chance of solving a hash problem, they further must consider the significant amount of electrical power in search of the solution. Generally, the block rewards outweigh electricity and equipment costs, but this may not always be the case. The current value, not the long-term value, of the cryptocurrency supports the reward scheme to incentivize miners to engage in costly mining activities. In 2018, Bitcoin's design caused a 1.4% welfare loss compared to an efficient cash system, while a cash system with 2% money growth has a minor 0.003% welfare cost. The main source for this inefficiency is the large mining cost, which is estimated to be US$360 million per year. This translates into users being willing to accept a cash system with an inflation rate of 230% before being better off using Bitcoin as a means of payment. However, the efficiency of the Bitcoin system can be significantly improved by optimizing the rate of coin creation and minimizing transaction fees. Another potential improvement is to eliminate inefficient mining activities by changing the consensus protocol altogether. ### Transaction fees Transaction fees for cryptocurrency depend mainly on the [supply](https://en.wikipedia.org/wiki/Supply_and_demand) of network capacity at the time, versus the [demand](https://en.wikipedia.org/wiki/Supply_and_demand) from the currency holder for a faster transaction.\[[_citation needed_](https://en.wikipedia.org/wiki/Wikipedia:Citation_needed)\] The currency holder can choose a specific transaction fee, while network entities process transactions in order of highest offered fee to lowest.\[[_citation needed_](https://en.wikipedia.org/wiki/Wikipedia:Citation_needed)\] Cryptocurrency exchanges can simplify the process for currency holders by offering priority alternatives and thereby determine which fee will likely cause the transaction to be processed in the requested time.\[[_citation needed_](https://en.wikipedia.org/wiki/Wikipedia:Citation_needed)\] For [Ethereum](https://en.wikipedia.org/wiki/Ethereum), transaction fees differ by computational complexity, bandwidth use, and storage needs, while Bitcoin transaction fees differ by transaction size and whether the transaction uses [SegWit](https://en.wikipedia.org/wiki/SegWit). In February 2023, the median transaction fee for Ether corresponded to $2.2845, while for Bitcoin it corresponded to $0.659. Some cryptocurrencies have no transaction fees, and instead rely on [client-side](https://en.wikipedia.org/wiki/Client-side) proof-of-work as the transaction prioritization and anti-spam mechanism. ### Exchanges _Main article:_ [_Cryptocurrency exchange_](https://en.wikipedia.org/wiki/Cryptocurrency_exchange) [Cryptocurrency exchanges](https://en.wikipedia.org/wiki/Cryptocurrency_exchange) allow customers to trade cryptocurrencies for other assets, such as conventional [fiat money](https://en.wikipedia.org/wiki/Fiat_money), or to trade between different digital currencies. Crypto marketplaces do not guarantee that an investor is completing a purchase or trade at the optimal price. As a result, as of 2020 it was possible to [arbitrage](https://en.wikipedia.org/wiki/Arbitrage) to find the difference in price across several markets. ### Atomic swaps Atomic swaps are a mechanism where one cryptocurrency can be exchanged directly for another cryptocurrency, without the need for a trusted third party such as an exchange. ### Initial coin offerings An [initial coin offering](https://en.wikipedia.org/wiki/Initial_coin_offering) (ICO) is a controversial means of raising funds for a new cryptocurrency venture. An ICO may be used by startups with the intention of avoiding regulation. However, securities regulators in many jurisdictions, including in the U.S., and Canada, have indicated that if a coin or token is an "investment contract" (e.g., under the Howey test, i.e., an investment of money with a reasonable expectation of profit based significantly on the entrepreneurial or managerial efforts of others), it is a security and is subject to securities regulation. In an ICO campaign, a percentage of the cryptocurrency (usually in the form of "tokens") is sold to early backers of the project in exchange for legal tender or other cryptocurrencies, often Bitcoin or Ether. According to [PricewaterhouseCoopers](https://en.wikipedia.org/wiki/PricewaterhouseCoopers), four of the 10 biggest proposed initial coin offerings have used [Switzerland](https://en.wikipedia.org/wiki/Switzerland) as a base, where they are frequently registered as non-profit foundations. The Swiss regulatory agency [FINMA](https://en.wikipedia.org/wiki/Swiss_Financial_Market_Supervisory_Authority) stated that it would take a "balanced approach" to ICO projects and would allow "legitimate innovators to navigate the regulatory landscape and so launch their projects in a way consistent with national laws protecting investors and the integrity of the financial system." In response to numerous requests by industry representatives, a legislative ICO working group began to issue legal guidelines in 2018, which are intended to remove uncertainty from cryptocurrency offerings and to establish sustainable business practices. ### Price trends The [market capitalization](https://en.wikipedia.org/wiki/Market_capitalization) of a cryptocurrency is calculated by multiplying the price by the number of coins in circulation. The total cryptocurrency market cap has historically been dominated by Bitcoin accounting for at least 50% of the market cap value where altcoins have increased and decreased in market cap value in relation to Bitcoin. Bitcoin's value is largely determined by speculation among other technological limiting factors known as blockchain rewards coded into the architecture technology of Bitcoin itself. The cryptocurrency market cap follows a trend known as the "halving", which is when the block rewards received from Bitcoin are halved due to technological mandated limited factors instilled into Bitcoin which in turn limits the supply of Bitcoin. As the date reaches near of a halving (twice thus far historically) the cryptocurrency market cap increases, followed by a downtrend. By June 2021, cryptocurrency had begun to be offered by some wealth managers in the US for [401(k)s](https://en.wikipedia.org/wiki/401\(k\)). ### Volatility Cryptocurrency prices are much more volatile than established financial assets such as [stocks](https://en.wikipedia.org/wiki/Stock). For example, over one week in May 2022, Bitcoin lost 20% of its value and Ethereum lost 26%, while [Solana](https://en.wikipedia.org/wiki/Solana_\(blockchain_platform\)) and [Cardano](https://en.wikipedia.org/wiki/Cardano_\(blockchain_platform\)) lost 41% and 35% respectively. The falls were attributed to warnings about inflation. By comparison, in the same week, the [Nasdaq](https://en.wikipedia.org/wiki/Nasdaq-100) tech stock index fell 7.6 per cent and the [FTSE 100](https://en.wikipedia.org/wiki/FTSE_100_Index) was 3.6 per cent down. In the longer term, of the [10 leading cryptocurrencies](https://en.wikipedia.org/wiki/List_of_cryptocurrencies) identified by the total value of coins in circulation in January 2018, only four (Bitcoin, Ethereum, Cardano [https://opensea.io/assets/0xFE3ca380E5C6309D9DcF86757e28b15Dc7509098/1](https://opensea.io/assets/0xFE3ca380E5C6309D9DcF86757e28b15Dc7509098/1) and [Ripple](https://en.wikipedia.org/wiki/Ripple_\(payment_protocol\)) (XRP)) were still in that position in early 2022. The total value of all cryptocurrencies was $2 trillion at the end of 2021, but had halved nine months later. The Wall Street Journal has commented that the crypto sector has become “intertwined” with the rest of the capital markets and “sensitive to the same forces that drive tech stocks and other risk assets”, such as inflation forecasts. ### Databases There are also _centralized_ databases, outside of blockchains, that store crypto market data. Compared to the blockchain, databases perform fast as there is no verification process. Four of the most popular cryptocurrency market databases are CoinMarketCap, CoinGecko, BraveNewCoin, and Cryptocompare. --- *Originally published on [Milosh Yarosh](https://paragraph.com/@kyivland/economics-in-crypto)*